Non-financial broad money (i.e. M4 held by households and private non-financial corporations) increased by a modest 0.2% in September but six-month growth rose again to 2.6%, or 5.3% annualised – the fastest since May 2008. Such a pace, if sustained, is probably incompatible with achieving the 2% inflation target, allowing for an upward trend in the velocity of circulation stemming from super-low interest rates.
Deflated by seasonally-adjusted consumer prices, non-financial M4 rose by 1.3% (2.7% annualised) in the six months to September. This is down from a peak of 1.6% in June but still higher than in any month between May 2009 and April 2012. Similar real growth in early 2009 preceded a year of solid economic expansion – non-oil GDP rose by 2.5% between the third quarters of 2009 and 2010.
“Monetarist” economists of a dovish persuasion argue that QE has been key to the money supply pick-up so an extension is necessary to prevent a relapse. There are two counter-arguments. First, recent gilt-buying will probably have significant lagged effects and, as noted, current money growth is probably too high. This argues for suspending QE pending clarification from the data about underlying monetary strength.
Secondly, QE is not the sole driver of faster monetary expansion – there has also been a significant positive contribution this year from banks’ reducing their non-deposit sterling funding. This trend may continue, with banks using cheap FLS borrowing to buy back debt. FLS should also lead to some revival in private-sector lending: one glimmer of hope is a moderation in the annual decline in sterling credit facilities – including loans arranged but not yet drawn down – from 11.1% in August to 6.6% in September, the smallest since August 2010.
Rather than a monetary slump should QE end, the main domestic threat to economic prospects is another inflation squeeze on real money expansion – the six-month change in seasonally-adjusted consumer prices has already started to firm, as the chart shows. However, recent oil price weakness and sterling appreciation – if sustained – should temper the near-term inflation pick-up.